Where’s the growth? The Personal Income and Spending report that came out today along with January’s sharp downward revision should have markets concerned. Inflation for Q1 (via PCE deflator) implies an annual inflation rate of 1.0%, well below the Fed’s target of 2.0%. The only thing the Fed is holding their hat with is employment growth so the job report this Friday could rock markets if it fails to impress. If there is good news, it’s that the market only expects 210k jobs added in March versus the 242k that were added in Feb.
Dot Plot – every three months the Federal Reserve publishes a chart showing where officials think the Fed Funds Rate will be at various points in the future. It essentially is a guide to what each member thinks the Fed should do at each meeting with regard to the key interest rate. This is not an interest rate forecast, it’s a guessing game by each individual member of the Fed about what might transpire in a future meeting. Let me repeat, it’s not a collective forecast of interest rates and yet that’s exactly what the market uses the chart for. There is a small push to get rid of the dot plots. James Bullard, head of St. Louis Fed has considered dropping out altogether from the exercise. He believes, as do I, that the predictive exercise by the Fed is being taken as a promise to the markets. The Fed has maintained they are ‘winging it at every meeting’, so why trust some silly dots? After all, the average prediction from every single dot plot for the past several years has been 100 percent wrong.
Permazero – in summary, the Fed is trying to keep interest rates low to help reduce unemployment and bring inflation up to 2% per year. Now we stand at 7+ years of rates at or near 0%, falling yields around the world with many below zero. The Fed wants to bring rates up to a normal level. So what is a normal level of rates after what’s transpired over the last 7 years? Mr. Bullard indicated that the Fed could leave rates near zero and that the market will determine the real level of rates and inflation expectations (the true components of interest rates). So why not leave rates at zero indefinitely?
Today the 10yr is at 1.87%, almost exactly where they were 1yr ago. The next FOMC meeting is April 27th with only at 6% probability of a Fed hike versus 50% as of Dec 31st last year. The market has priced in a 36% chance for a hike in June and only 72% by year end. If you recall the Fed had originally assumed four rate hikes this year and the last dot plot implies only two. Given that the Fed is reluctant to change their plots too much (in an effort not to lose credibility), I wonder if the latest plot truly represents their expectation…. Also, if you’ve decided to ‘wing it’, doesn’t that mean you have no idea what is going to happen? I smell upcoming volatility with a better chance that rates drop than they rise.